St. Lucia: Staff Report for the 2017 Article IV Consultation
Author:
International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
31 Mar 2017
eISBN:
9781475590906
ISBN:
9781475590906
Language:
English
Keywords:
ISCR; CR; GDP; financing terms; executive board assessment; headline inflation; due diligence; physical capital; bank weakness; Fiscal stance; Caribbean
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Despite some limited improvement in labor market conditions, unemployment remains high and growth modest as low competitiveness and structural bottlenecks continue to weigh on economic performance. Slow progress in addressing financial sector problems has left banks loaded with impaired assets and unable to support the economy. The new government is developing a program of pro-growth reforms, but policies have not yet been defined.

Abstract

Despite some limited improvement in labor market conditions, unemployment remains high and growth modest as low competitiveness and structural bottlenecks continue to weigh on economic performance. Slow progress in addressing financial sector problems has left banks loaded with impaired assets and unable to support the economy. The new government is developing a program of pro-growth reforms, but policies have not yet been defined.

Recent Developments and Outlook

A. Context

1. Long-standing challenges hinder St. Lucia’s economic performance. The largest economy in the Eastern Caribbean Currency Union (ECCU), St. Lucia is a small island developing state of upper-middle income with strong social indicators. With the erosion of EU trade preferences starting in the 1990s, St. Lucia downsized its traditional banana production and became heavily reliant on tourism. A narrow production base, low productivity, strong dependence on imported fossil fuel, and exposure to natural disasters hamper St. Lucia’s growth potential. The Global Financial Crisis highlighted these weaknesses, with a dramatic reduction of tourist inflows spilling over the rest of the economy, raising unemployment, and inflating bank nonperforming loans (NPLs). The government tried to cushion the impact of the crisis with public sector wage increases, construction stimulus, and large labor market programs, leading to a substantial increase in public debt.

2. Supported by favorable external conditions, the economy has emerged slowly from the Great Recession. Economic recovery in the main tourist markets (the United States and the United Kingdom) and declining oil prices have supported a tepid increase in economic activity. Unemployment has declined although remains high, the external current account deficit has narrowed sharply from the peaks reached during the Global Financial Crisis, and some fiscal adjustment has been achieved with revenue increases —including through the introduction of a VAT—, enhanced tax compliance, a public sector nominal wage freeze, and reduced capital spending forced by financing constraints. The banking sector, however, continues to be encumbered by NPLs and credit growth remains negative.

3. The new administration is developing a reform program, but key policies are still being shaped. After general elections held in June 2016, a new government was installed with a solid parliamentary majority. Its pro-growth reform agenda calls for a broad tax reform, a reorganization of the public sector, a revision of the Citizenship by Investment Program (CIP), and structural reforms to improve the business climate and encourage foreign direct investment (FDI). However, details on policies are still pending and many of the reforms will take time to yield results. In the meantime, rising public debt needs to be tackled to reduce risks to the implementation of the economic program.

B. Current Trends

4. Growth weakened in 2016 on the back of a disappointing tourist season. Driven by agriculture and construction, GDP growth is estimated to have reached 0.8 percent in 2016, down from 1.8 percent in 2015 (Table 1 and Figure 1). Strong employment growth in agriculture and construction put a dent on unemployment, which declined to 20 percent in the third quarter of 2016. Youth unemployment also fell, but remains very high at 41 percent (Table 6). Nonetheless, weakness in tourism, manufacturing, and transportation dampened growth. Stay-over arrivals increased by only 0.7 percent and overall tourist expenditure fell by 5 percent, one of the worst performances among ECCU tourist destinations. Exports of goods also declined, contributing to widen the current account deficit to an estimated 6.7 percent of GDP in 2016 (Table 3). Headline inflation was driven down by import prices, and lingered in negative territory over the last 12 months, while core inflation moved closer to zero.

Table 1.

St. Lucia: Selected Social and Economic Indicators, 2013–2022

article image
Sources: St. Lucia authorities; ECCB; and Fund staff estimates and projections.

Fiscal year (April–March) basis.

Comprises public sector external debt, foreign liabilities of commercial banks and other private debt.

Figure 1.
Figure 1.

Mixed Macroeconomic Outcomes Despite Favorable Global Conditions

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

A01ufig1

Employment

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Source: National Competitiveness and Productivity Council, St. Lucia Statistical Office.

5. The fiscal stance deteriorated in 2016, partly reflecting rising capital spending and interest payments. The government has been able to expand its financing and shift from short-term T-bills to longer-term bonds, which allowed it to increase capital spending while reducing rollover risks. Lengthening the maturity of debt, however, has also raised its cost, thus adding to the escalating dynamics of interest payments. The overall fiscal deficit is estimated to have increased from 2.6 percent of GDP in FY 2015/16 to 4.4 percent of GDP in FY 2016/17, prompting public debt to reverse its previous decline and rise to almost 83 percent of GDP (Tables 2a, 2b).

Table 2a.

St. Lucia: The Statement of Operations of the Central Government 1/

(In millions of EC dollars)

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Sources: Ministry of Finance; and Fund staff estimates and projections.

Fiscal year (April–March) basis.

Natural disaster costs are annualized estimated costs (see Box 1).

Direct debt and debt of the parastatal entities (including debt guaranteed by the central government).

Table 2b.

St. Lucia: The Statement of Operations of the Central Government 1/

(In percent of GDP)

article image
Sources: Ministry of Finance; and Fund staff estimates and projections.

Fiscal year (April–March) basis. Figures shown for a given calendar year relate to the fiscal year beginning on April 1 of that year.

Natural disaster costs are annualized estimated costs (see Box 1).

Direct debt and debt of the parastatal entities guaranteed by the central government.

Table 3.

St. Lucia: Balance of Payments Summary, 2013–2022

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Sources: Ministry of Finance and Planning; ECCB; World Bank, and Fund staff estimates and projections.

Includes largely gross foreign liabilities of commercial banks and other private debt.

6. The fiscal package recently adopted by the new government further weakens the fiscal position and may not have the desired impact on growth. In line with the “Five to Stay Alive” electoral manifesto, the prime minister last November announced a number of tax reductions, including a cut to the VAT rate from 15 to 12.5 percent —effective February 1, 2017—, and increases in transfers totaling 1¾ percent of GDP.1 As an offsetting measure, effective April 1, 2017, the government plans to increase airport taxes from US$25 to US$98, one of the highest levels in the Caribbean. Staff expects this measure to yield revenues of 0.6 percent of GDP, with a net impact of the total fiscal package on the overall balance of -1.2 percent of GDP. The steep rise in airport taxes, however, is likely to have negative effects on tourism, which could overwhelm any positive impact on growth from the other measures.2

Impact of New Government Measures on Fiscal Balance

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Sources: Ministry of Finance of St. Lucia and IMF staff estimates.

40 percent of additional tax revenues will be assigned to the budget of the central government.

7. Bank lending continues to contract. Credit growth remains negative, reflecting weak demand and the high level of NPLs still burdening banks (Figure 2 and Table 5). In the meantime, banks are shifting credit allocation from tourism and manufacturing to more profitable personal and professional loans, in particular mortgage and vehicle loans.

Figure 2.
Figure 2.

Strengthening the Financial Sector

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: Country authorities; and IMF staff estimates.
Table 4.

St. Lucia: Monetary Survey, 2013–2017

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Sources: St. Lucia authorities; ECCB; and Fund staff estimates and projections.

End-of-period rates.

Table 5.

St. Lucia: Banking System Summary Data, 2010–2016

article image
Sources: ECCB; and IMF staff estimates.
Table 6.

St. Lucia: Selected Labor Market Indicators, 2010–2015

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Sources: St. Lucia Population and Housing Census; and National Insurance Corporation.

C. Outlook

8. Modest growth is expected in the short term. GDP is projected to grow at 0.5 percent in 2017, driven mostly by continued strong performance in construction and agriculture. Despite positive developments —the increase in the number of hotel rooms and the opening of new direct flights from the U.S.— tourism arrivals are projected to be stifled by the impact of the new airport tax while exchange rate and cyclical developments will continue to inhibit inflows from the U.K. Higher import prices, including oil, will cause inflation to rise temporarily and, together with weak tourist expenditures, will contribute to widen external imbalances. Without significant changes in fiscal policies, revenues are projected to decline as a share of GDP, accelerating the deterioration of the fiscal balance. Such dynamics would likely curtail government financing and severely constrain the implementation of investment projects. With slow progress in cleaning up their balance sheets, banks are expected to further shrink their loan portfolio.

9. In the absence of stronger policies, the medium-term outlook is held back by structural weaknesses. Growth is expected to revert to its medium-term rate of 1.5 percent in 2018, as FDI in hotels sustains construction activity and expands capacity in the tourism industry. While the forthcoming budget should bring some clarity about fiscal policy, in the absence of corrective measures, rising interest payments will add to expenditure pressures, leading public debt to an unsustainable path. As commodity prices gradually rise from recent lows, the current account deficit will widen, reflecting low competitiveness. Unless structural reforms are implemented, rigidities in the labor market, high costs of doing business, and low external competitiveness will continue to weigh on growth.

10. Downside risks dominate. While the baseline is built on the assumption of no significant policy corrections, the government has the opportunity to design and put in place appropriate policies that address key fiscal, external, and structural vulnerabilities. Together with the possibility that FDI inflows turn out to be higher than expected, this is an important upside risk to the projections (Annex I). However, several downside risks stem from both external conditions and domestic policies. In the absence of a sufficient fiscal correction, financing conditions could be much tighter than currently projected, forcing a sharp, disorderly fiscal adjustment that would have a negative impact on growth. A stronger-than-expected U.S. dollar appreciation would further reduce competitiveness. Owing to global instability and low medium-term growth in advanced and emerging economies, weak external demand could reduce tourist inflows. Although natural disasters are internalized in the macroeconomic framework using historical averages (Box 1), larger and more frequent disasters could occur. Slow progress in addressing bank weaknesses could undermine financial stability and growth.

St. Lucia: Central Government Cash Flows Under a Passive Scenario 1/

(Millions of Eastern Caribbean dollars, Fiscal Years)

article image

Projections assume no asset transactions and that existing investors roll over maturing debt. Scenario assumes that there are no significant changes in fiscal policy in the future.

Ensuring Fiscal Sustainability and Fostering Growth

A. Fiscal Policies

11. The current fiscal stance is inconsistent with fiscal and debt sustainability. In line with what happened in the recent past, staff assumes that further deterioration in the fiscal balance will reduce market access, leading to a curtailment of investment projects (baseline scenario). Even under this assumption, debt is unsustainable under the baseline of no significant change in policies. With high public debt, interest payments are expected to rise, reflecting an increased risk premium and the prospective increase in world interest rates.3

12. Fiscal consolidation, which is needed to stabilize debt, can be aligned with the authorities’ objective of reforming the tax system. With relatively high tax rates and tax revenues at some 25 percent of GDP, St. Lucia’s tax burden is above comparators, despite tax concessions estimated at about 7 percent of GDP, above the Caribbean average of 6.1 percent of GDP. Significantly streamlining exemptions would generate fiscal space for sustainable tax cuts and the creation of a social safety net to protect low-income households. After sufficiently broadening the tax base, consideration could be given to reducing high tariffs and other taxes on imports which, by increasing import value by 20 percent (before VAT) on average, are particularly harmful to competitiveness.

Tax Rates: Regional Averages (2016) 1/

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Sources: WDI; Ernst & Young; KPMG and IMF staff estimates.

As of latest available.

Simple average of latest available data on WDI Database (2010-14).

Based on World Bank’s Small States classification.

Small Competitive group corresponds to the simple average of Estonia, Iceland, and Mauritius.

A01ufig2

2015: Goverment Tax Revenue

(In percent of GDP)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

1/ Countries include Estonia, Iceland, and Mauritius.Source: WEO; and IMF staff estimates.
A01ufig3

2015: Components of Total Tax Revenue

(In percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: WEO; and IMF staff estimates.

13. The public sector wage bill has a key role in expenditure control. Relative to comparators, compensation of employees is high while social expenditure is low. Despite the recent wage freeze, the government continues to devote a large share of its spending to employee compensation. In addition, temporary work programs cost the equivalent of 1 percent of GDP. On the other hand, spending on health, tertiary education, pensions and social assistance remains below relevant comparators as a share of GDP (Figure 3). Capital spending was relatively high in 2015, but the stock of public capital is comparatively low.

Figure 3.
Figure 3.

Main Social Spending Items Relative to Comparator Groups

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: IMF staff estimates.
A01ufig4

2015: Goverment Spending

(In percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: National authorities; and IMF staff estimates.
A01ufig5

Public Capital Stock

(Latest value available)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: National authorities; and IMF staff estimates.

14. The ECCU debt target of 60 percent of GDP by 2030 is an appropriate anchor for the adjustment effort. This effort, which in net terms would require a fiscal adjustment of 4.4 percent of GDP, could be extended over six years through 2022, after which debt dynamics would lead to the attainment of the debt target in 2030. The focus should be on broadening the tax base, controlling expenditure, and improving financing terms while preserving capital spending and protecting low-income households (text table and Figure 4).

Figure 4.
Figure 4.

Baseline, Passive, and Adjustment Scenarios

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: Country authorities; and IMF staff estimates.

  • On the revenue side, the elimination of selected VAT exemptions and reduced VAT rates, and the removal of non-targeted subsidies could yield 1.5 percent of GDP, of which 0.5 percent of GDP could be used to reverse part of the increase in the airport tax. In addition, the authorities could consider reducing import duties by 25 percent, which could be fully financed by reducing concessions by half.

  • On the expenditure side, control of the wage bill and reduction in other non-interest expenditures would produce savings of 3.7 percent of GDP. The former could be obtained by anchoring wage growth to CPI inflation (1.5 percent of GDP) and other measures (0.7 percent of GDP) such as attrition, review of pay systems in education, payroll audits, benchmarking with private sector wages, and performance-based pay. These fiscal savings would create room to build a targeted social safety net (0.5 percent of GDP).

  • Higher capital spending and structural reforms under the adjustment scenario would lead to higher medium-term growth of 2 percent.

  • The use of concessional finance, enhancements in the bond market, and a lower debt level, would lead to savings of 2.9 percent of GDP in interest payments.

Figure 5.
Figure 5.

Structural Reform Priorities to Drive Growth

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Figure 6.
Figure 6.

Unemployment in St. Lucia

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

A01ufig6

Public Debt

(percent of GDP, fiscal years)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Staff Recommended Adjustment Scenario 1/

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Source: IMF staff calculations

Fiscal year (April-March) basis. Both passive and adjustment scenarios incorporate the annualized natural disaster cost described in Box1.

15. A medium-term fiscal framework should account for the frequent occurrence of natural disasters. St. Lucia, like other countries in the region, is heavily exposed to natural disasters, which entail significant economic costs in terms of investment, GDP, unemployment, poverty, and fiscal revenues. These costs can be substantially reduced by appropriate policies that mitigate disaster-related risks and provide financing of these costs prior to the event. While optimal financing is likely to involve a mix of fiscal buffers, contingent financing plans, and insurance, budget provisions of 1 percent of GDP per year are likely to be needed to address direct fiscal costs (Box 1).

Estimating the Cost of Natural Disasters

In the absence of insurance and other forms of financing, budget provisions should cover the average annual fiscal cost of natural disasters. Based on EM-DAT data for the period 1950-2014, the average annual impact of natural disasters in St. Lucia is 1.5 percent of GDP. This figure, however, includes costs borne directly by the private sector. According to the World Bank’s Post Disaster Needs Assessments (PDNAs) available in recent years for small island states, private costs average 45 percent of total damages and losses, but vary widely between 8 and 83 percent.

Using these values for St. Lucia, the annual cost to the government would be 0.8 percent of GDP, but it could be as high as 1.4 percent of GDP. A cautious approach suggests that an assumption of 1 percent, slightly higher than the average value, is appropriate for St. Lucia. This is confirmed indirectly by Guerson (2016), which, using Monte Carlo simulations to assess the appropriate size of a government savings fund to insure against natural disasters, estimates that the necessary annual budget saving for St. Lucia would be 1.05 percent of GDP.

1/ Guerson, Alejandro (2016) “Assessing Government Self-Insurance Needs Against Natural Disasters: An Application to the ECCU”, Eastern Caribbean Currency Union, 2016 Discussion of Common Policies of Member Countries, Annex VIII, IMF Country Report No. 16/333.

16. The authorities are making progress toward establishing a medium-term fiscal framework. Welcome provisions in the Public Financial Management (PFM) Bill commit the Ministry of Finance to adopt a formal medium-term fiscal plan (MTFP) (Box 2). However, the bill does not explicitly require the submission of the MTFP to Parliament for approval with the budget nor is there any explicit obligation to publish the MTFP and the accompanying fiscal statement, the content of which is yet to be defined. However, publication of the appropriation law and of the related budget estimates is required. Apart from requiring publication of the MTFP and fiscal statement, useful additions to the current bill would be the adoption of a new chart of accounts in line with GFS standards. The authorities should also consider expanding their definition of debt to the consolidated non-financial public sector to make sure that all public debt-generating bodies are monitored.

17. An appropriate fiscal rule would be useful to support the adjustment effort, but the draft PFM bill falls short of establishing a clear link with the debt target. The bill does define the medium-term debt anchor, but budget preparation and intermediate targets are not explicitly linked to it. Moreover, the bill defines “hard” targets for the current financial year, but only “indicative” targets for the outer two years. To enhance accountability and strengthen the commitment to debt sustainability, a separate Fiscal Responsibility Act would be required to translate the debt target into domestic legislation and define a quantitative fiscal rule to guide the formulation of the MTFP.

The PFM Bill

The new PFM Act will repeal the current Finance Administration Act. At the time of writing, the PFM bill has important features strengthening fiscal discipline. In particular, the bill provides for:

  • The Minister of Finance (MOF) to commit to: (i) prudent fiscal policy and fiscal stability over a multiyear horizon; and (ii) promote transparency and accountability (Art. 5(2)).

  • The Accountant General to support agencies in preparing financial projections and supervise and guide agencies to comply with the intent of the Act (Art. 9(1)).

  • The MOF to formulate a three-year medium term fiscal plan (MTFP) and submit to Parliament an accompanying fiscal statement. The statement would review budgetary performance and identify measures needed to meet budgetary and plan targets, and state fiscal risks to the economy and the debt situation (Art. 16 and 17).

  • The MOF to indicate an aggregate budget ceiling for the upcoming financial year and indicative ceilings for the following two years. The aggregate ceiling for the upcoming year should be accompanied by separate recurrent and capital expenditure ceilings (Art. 17).

18. CIP revenues are expected to bring increased revenues, which however carry risks. Introduced in January 2016, the citizenship program has attracted only marginal interest thus far. To increase the competitiveness of the program, the government has introduced significant changes (Box 3). These changes are expected to boost revenues, which the authorities plan to collect into a sovereign wealth fund to be used mostly to fund investment. Like other citizenship programs, St. Lucia’s CIP entails significant reputational and financial integrity risks, which could be minimized by strict adherence to standards for due diligence, governance, and transparency. The same principles should apply to the wealth fund, which should give priority to debt reduction to contain risks of fiscal dependence on these volatile revenues and follow transparent criteria in its operations. Strengthening public investment management would help ensure that only high-yield projects are selected.

Changes in the Citizenship by Investment Program

St. Lucia introduced its Citizenship by Investment Program (CIP) in 2016 with the intention to attract investments in high-end hotel and real estate products, and employment-generating business enterprises. Additionally, the program envisaged a donation to the Economic Fund and investment in an interest-free government bond as additional options. The program was targeted at individuals of high-net worth and an annual cap on the number of citizenships under the program was imposed.

The program met limited success in its first year of operation. CIP performance was poor, owing to comparatively high requirements and the expectations that a new government might change policies after the elections. Six applications were approved under the real estate option, but none of them had reached investment stage at the time of the discussions. Fourteen applications were accepted under the donation option for a total of US$1.4 million and five applications were approved under the bond option for US$2.7 million. No interest was shown in the enterprise investment option.

The new government introduced several changes to make the program more competitive. The requirement for an affidavit to declare financial resources of at least US$3 million was removed. The required contribution to the Economic Fund was reduced from US$200,000 to US$100,000 for single applicants and fees for applicants with dependents were reduced as well. An administrative fee of US$50,000 was introduced for the bond option. The cap of 500 citizenships per year has been removed. The remaining two options to obtain citizenship through investment remain the same. Citizenship can be obtained through a minimum investment amount of US$300,000 in a government-approved real estate project or an investment in an approved enterprise project starting from US$1 million.

The authorities expect these changes to significantly boost applications and revenues. In 2017/2018 a total revenue of US$9 million is expected through donations, of which 80 percent will be transferred to the government and the rest used to cover the operations of the CIP office. The real estate option is expected to bring 36 applications. Owing to the newly imposed fee, the interest in government bonds is expected to be limited.

The proceeds from the program will be collected in a sovereign wealth fund. The intention is for all CIP revenues to be transferred to a soon-to-be-announced sovereign wealth fund that will be owned, but not operated, by the government. The fund could then be used to finance investment projects and buy back debt.

B. Financial Sector Policies

19. Persisting weakness in the banking sector hampers economic growth. NPLs are high at 21.8 and 12.5 percent for indigenous and foreign banks, respectively (Table 5). As banks attempt to increase provisioning, profitability remains low or negative. Limits in the regulatory framework — which prevents creditors from owning the collateral in case of foreclosure—, underdeveloped insolvency and debt restructuring frameworks, and low liquidity of the real estate market reduce the value of collateral. With provisions for impaired assets averaging only 50 percent, capital adequacy remains low once NPLs are written off. Against this background, banks continue to deleverage and reduce lending.

20. Low bank profitability and excess liquidity are aggravated by distortions to banking conditions. The regional minimum savings rate (MSR), which was reduced in 2015 to 2 percent by the Eastern Caribbean Central Bank (ECCB), aims to protect small depositors. However, it has prevented a decline of deposit rates in conditions of excess liquidity, contributing to low bank profitability, high lending rates, and reinforcing weak loan demand and bank excess liquidity.

21. Large liquidity buffers, however, mitigate risks to financial stability. With a loan to deposit ratio of about 90 percent, banks have a large volume of liquid assets that can be used to repay depositors. At the end of 2016, the liquidity coverage ratio stood at 37 percent while coverage of deposits stood at 48 percent (text figures and Table 5).

A01ufig7

St. Lucia: Loans-to-Deposits Ratio

(Percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

A01ufig8

St. Lucia: Liquid Assets

(Percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

22. The loss of correspondent banking relationships (CBRs) has been limited to the offshore sector, but CBR-related costs have increased substantially. Most domestic banks have been forced to dedicate more resources to due diligence and increased data reporting while correspondent banking fees for indigenous banks have reportedly increased by some 30-to-40 percent over the last five years. In some cases, banks had to terminate certain services, such as Euro check clearance. To address these issues, the authorities, jointly with the ECCB, are continuing to strengthen their regulatory frameworks, including for AML/CFT and international tax cooperation. In particular, St. Lucia has established automatic exchange of tax information with the U.S. under the Foreign Account Tax Compliance Act (FATCA), signed MOUs for tax information exchange with 32 jurisdictions, and strengthened legislative provisions to improve the availability of ownership and accounting information. Finally, the authorities have committed to adopting the OECD Common Reporting Standard for automatic exchange of tax information.

23. Progress in strengthening the financial sector remains slow. A new insolvency bill is under preparation, but the regional asset management company (ECAMC) for resolution of bank NPLs has not yet been established as some jurisdictions have not provided the necessary financial support. In the non-bank financial sector, a risk-based supervision framework has been introduced for the large number of regulated entities.4 However, support for a new insurance bill —which would provide for regional regulation and supervision of the sector and allow companies to freely operate in the ECCU single market— is dwindling.

C. Structural Reforms

24. Despite recent improvements, addressing high structural unemployment is a priority. Several factors seem to be at play (Annex VI). Skills mismatches are pervasive and aggravated by brain drain, mostly directed to the U.S. and other parts of the Caribbean. Workers with specialized skills, such as electricians or plumbers, are also scarce, sometimes forcing firms to employ foreign workers. Possibly owing to strong unions, the link between wages and productivity is very weak, hindering external competitiveness (Annex V). Policies are focused on treating the symptoms with temporary work programs, both domestically and overseas, but a comprehensive strategy to tackle the problem at its roots is missing.

25. Education and training are key components of the solution. A review of the education system would allow to identify how the system is performing in relation to its high cost — particularly in the primary and secondary components— and the needs of the labor market. The national curriculum may also need to be revised. Beyond the formal education system, targeted training and stronger incentives for on-the-job training and apprenticeships would help address the skills mismatch. A gradual move to performance-based pay in the public sector, which leads wages in the private sector, would help better align wages with productivity. Specific measures may also be needed to address female unemployment, which remains particularly high.

26. Costs of doing business remain high. The authorities have made some progress on a program of structural reforms under the Caribbean Growth Forum, which focus on improving skills and productivity, logistics and connectivity, and investment climate. In addition, the six-pillar Long-Term National Development Plan is expected to target building human and physical capital, strengthening institutions, improving social resilience, and mitigating and adapting to climate change. However, high costs of trading —including costs of port operations and import duties— and energy and low access to credit remain considerable obstacles.

27. Progress on reducing energy costs has been limited. To reduce their almost total dependence on fossil fuels, the authorities are promoting the adoption of renewable sources, but the 2020 target of 35 percent for the share of renewables is unlikely to be reached owing to delays in the implementation of the wind and geothermal components. Moreover, regulatory impediments and the need to recover investment costs could dissuade investment in renewable sources and prevent savings being transmitted to final users. In particular, the current legislation prevents individual producers of solar energy —households and businesses— from selling their excess supply to the grid, substantially reducing the advantages of adopting this source.

D. The Authorities’ Position

28. The authorities were more optimistic on the growth outlook. They emphasized that the additional hotel capacity, new direct flights, and the establishment of a new Tourist Authority with an effective marketing strategy will boost tourist arrivals. In addition, the authorities do not share the staff’s negative assessment of the new airport tax. Pointing to their own analysis of the market and taking account of the airport tax levels pertaining elsewhere in the region, they believe that they will remain competitive.

29. The authorities acknowledged the need for fiscal adjustment to reach the ECCU-debt target of 60 percent of GDP by 2030, which they said they are committed to achieving. They agree with staff that broadening the tax base is necessary to improve the efficiency of the system and limit the erosion of tax revenues. They intend to follow this principle for a comprehensive reform of the tax system, which will be finalized based on the soon-to-be delivered assessment by an external consultant.5 However, the government considers VAT too complex for a small economy like St. Lucia and remains committed to reducing its rate while, being mindful of the fiscal situation, possibly offsetting the revenue loss with a sales tax. The government is also committed to controlling the wage bill and gradually improving social assistance, partly by fostering private sector participation in the provision of health and education services and improving the targeting of social assistance to the poor. In addition, the authorities agree that increasing their access to concessional financing is necessary to reduce effective interest rates.

30. The authorities recognized the need to further strengthen the fiscal framework and saw the new PFM legislation as appropriate for this purpose. In fact, the new MTFP targets would have the power of law under the new legislation. In the authorities’ view, the lack of a permanent rule-based operational guidance and legislated quantitative fiscal anchor does not detract from their strong commitment to fiscal discipline.

31. The authorities agreed that a prompt resolution of bank impaired assets is necessary to revive credit and support growth. They are confident that progress will accelerate in coming months, with the insolvency bill expected to be enacted in the second half of 2017 and the ECAMC to be operational by year-end. They acknowledge, however, that the new insurance legislation will require more time.

32. The authorities noted that more detail on structural policies will be available in the forthcoming budget presentation. Energy prices are seen as comparable with regional levels. The move toward renewable energy is mostly aimed at increasing efficiency and independence rather than reducing electricity costs to final users in the first instance. To address labor market rigidities and unemployment, the authorities are working on a revised labor code and considering a comprehensive education system reform. They are also working on developing strategies to tackle the issue of low productivity, including through the introduction of performance-based pay in the public sector.

Staff Appraisal

33. Growth remains subdued. In the short term, construction and agriculture should continue to perform strongly while growth in tourism —which should be driven by consistent inflows of U.S. tourist, new flights, and new hotels— could be stifled by the new airport tax. Slow progress in cleaning up bank balance sheets limits the extent to which banks can help sustain growth. In the medium term, rigidities in the labor market, a costly business environment, and low external competitiveness severely limit growth prospects. A comprehensive reform program is needed to appropriately address key weaknesses and improve growth prospects, but downside risks, both external and domestic, dominate the outlook.

34. The deterioration of the fiscal position, which has been accelerated by the recent fiscal package, should be addressed promptly and decisively in the context of the forthcoming budget. In the absence of corrective measures, financing difficulties will increase and force inefficient fiscal adjustment—typically by reducing already low capital spending—with negative effects on growth. At the same time, public debt will continue to increase with unsustainable dynamics. The FY2017/18 budget therefore presents an opportunity for the authorities to demonstrate their commitment to fiscal responsibility and clarify their intentions on a broad range of policies. A more stable fiscal position and reduced uncertainty about the government’s economic program would pave the way to stronger domestic and foreign investment.

35. Corrective measures should be supported by a multi-year consolidation plan to attain the 2030 debt target of 60 percent of GDP. The consolidation plan should address the need to prepare for the inevitable recurrence of natural disasters. To be consistent with the authorities’ intention to reform the tax system and reduce tax burdens, the adjustment effort could focus on broadening the tax base, controlling expenditure, and improving financing terms. The planned increase in the airport tax should be reconsidered if its negative growth effects do materialize. A reduction in the wage bill should be targeted through continued wage restraint and attrition. Social spending should be preserved and reoriented from temporary work programs and non-targeted subsidies to targeted social assistance. Concessional lending, rather than costly bond issuance, should be used to finance much needed investment in infrastructure, renewable energy, and natural disaster resilience, and partnerships with the private sector should be used when feasible. If enough fiscal space can be created, considerations should be given to reducing high taxes and duties on imports, which harm external competitiveness.

36. An appropriate fiscal rule would adequately support the adjustment effort. The PFM bill contains some welcome steps to strengthen the budget process and move toward a medium-term fiscal framework, but is not adequately tied to the debt target of 60 percent of GDP by 2030. A fiscal rule, enshrined in fiscal responsibility legislation, would be necessary to ensure the appropriate institutional arrangements for enhanced fiscal transparency and accountability.

37. Good governance of the citizenship program and of the sovereign wealth fund are essential to minimize risks and ensure good use of these additional resources. The recent changes to the CIP could provide a welcome boost to fiscal revenues. These revenues, however, are very volatile and the authorities’ decision to collect these funds in a sovereign wealth fund reduces the risk of fiscal dependence. As in other countries, the CIP entails significant reputational and financial integrity risks, which could be minimized by strict adherence to the highest standards for due diligence, governance, and transparency. The same principles should apply to the wealth fund, which should follow transparent criteria in its operations. Addressing remaining weaknesses in public investment management would ensure that only high-yield projects are selected. In view of the high public debt, priority should be given to its reduction.

38. Resolution of NPLs is critical to revive credit and support economic growth and renewed priority should be given to the establishment of the regional asset management company. New insolvency legislation will be an important step to facilitate foreclosures and debt restructuring. While the final steps to establish the ECAMC should be completed promptly by all jurisdictions, increased provisions for impaired assets by banks’ shareholders would facilitate the sale of NPLs. Continued efforts to implement international standards on AML/CFT and tax cooperation will be required to mitigate the risk of loss of CBRs.

39. Structural reforms remain critical to remove obstacles to long-term growth. Priorities include: (i) addressing skills mismatches and improving labor productivity by revising the national curriculum to match market demands and providing better training opportunities across sectors; (ii) aligning wages with productivity by gradually introducing performance-based pay in the public sector; (iii) removing obstacles preventing a more widespread adoption of solar energy or the passing of savings to final users; (iv) reducing costs to trade, including costs of port operations and import duties; and (v) addressing bank weaknesses to facilitate access to credit.

40. Statistics are adequate for surveillance. However, lack of resources is hampering quality in several areas. Data are subject to large revisions, which often reflect pre-existing weaknesses as methodological improvements are introduced. Adequate resources should be provided to the Central Statistics Office for data collection and compilation. The timeliness of data provision by government agencies should also be improved.

41. The 2016 update safeguards assessment found that the ECCB continues to maintain a governance framework that provides for independent oversight. Transparency in financial reporting has been maintained and the external audit mechanism is sound. The ECCB is taking steps to restructure the internal audit and risk management functions to align them with leading international practices.

42. Staff recommends that the next Article IV Consultation for St. Lucia take place on the standard 12-month cycle.

Annex I. Risk Assessment Matrix

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Annex II. Implementation of Previous Staff Advice

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Annex III. Debt Sustainability Analysis1

Public debt is unsustainable under the baseline scenario as projected debt levels and government financing needs are well above benchmark levels and increase throughout the projection period. Market access for long-term financing has recently improved, but this could easily change in the absence of stronger policies.

A. Background

1. St. Lucia’s debt has been increasing rapidly over the last two decades. The dramatic rise in public debt began around the time the traditional banana industry collapsed in the mid-1990s and was aggravated by the impact on tourism of the 9/11 terrorist attacks and the global financial crisis. Thus, between FY1996/97 and FY2014/15, public debt rose from 28 to 79 percent of GDP. Public debt as a share of GDP actually declined slightly in FY 2015/16 as a result of improved fiscal performance.

2. Central government obligations constitute the largest component of St. Lucia’s public debt and have been rising over time. These obligations include market-based securities, commercial bank bonds and loans, bilateral and multilateral debt, loans from the national insurance scheme (NIC), overdraft facilities, and outstanding payables. Public debt also includes government-guaranteed loans from domestic commercial banks and multilateral institutions to statutory enterprises. While central government debt has increased, government-guaranteed debt has declined in recent years.

3. Despite having access to concessional forms of project financing, the majority of St. Lucia’s debt is market-based and used for general budget financing. Bilateral and multilateral debt amounts to one quarter of total public debt, with the Caribbean Development Bank as the largest creditor. In contrast, the remaining three-quarters of St. Lucia’s debt instruments have been issued on commercial terms, of which 35 percent through the ECCU Regional Government Securities Market (RGSM). Other sources are the Trinidad and Tobago securities exchange, the Eastern Caribbean Securities Exchange, other private placements, and bonds and loans issued directly to the NIC.

4. Central government debt is fairly balanced between domestic and external creditors (52 and 48 percent, respectively by end-December 2016). Within domestic debt, non-bank financial institutions (including the NIC) and commercial banks hold the largest shares.

B. Public Debt Sustainability Analysis

5. Staff’s baseline scenario continues to project an unsustainable debt burden. Under the baseline macroeconomic framework increasing public debt affects investors’ appetite for St. Lucia’s debt instruments, thus leading to a gradual reduction in financing for public investment starting in FY 2018/19. Despite this financing constraint, public debt would continue to rise, reaching 95.6 percent of GDP by FY 2021/22 and 112.8 percent of GDP by FY2030/31, thus missing the 2030 debt target of 60 percent of GDP. As mentioned earlier in this staff report, the staff-proposed adjustment would result in a continued decline in public debt, reaching 60 percent of GDP by 2030 as intended by the authorities.

6. Under DSA adverse shock scenarios, the baseline debt path becomes even less sustainable (see Figure A5). The growth shock, which simulates a one standard deviation adverse shock to real GDP growth over 2016-17, has the most severe outcome among the single shock scenarios, with public debt reaching 103.3 percent of GDP by FY2021/22. Other adverse shock scenarios affect significantly the path of public debt. It is worth noting that the risk posed by an exchange rate shock is mitigated by the near-currency-board arrangement for the Eastern Caribbean dollar. Under the combined macro-fiscal shock public debt would reach 112.4 percent of GDP by FY2020/21. On the other hand, an alternative scenario taking into account staff’s recommended adjustment policies would gradually reduce financing needs and the debt-to-GDP-ratio.

Figure A1.
Figure A1.

St. Lucia: Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are:200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ EMBIG, an average over the last 3 months, 26-Oct-16 through 24-Jan-17.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Figure A2.
Figure A2.

St. Lucia: Public DSA – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Source: IMF Staff.1/ Plotted distribution includes all countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Not applicable for St. Lucia, as it meets neither the positive output gap criterion nor the private credit growth criterion.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
Figure A3.
Figure A3.

St. Lucia: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP, fiscal-year basis, unless otherwise indicated)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Source: IMF staff.1/ Public sector is defined as central government and includes public guarantees, defined as.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure A4.
Figure A4.

St. Lucia: Public DSA-Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Source: IMF staff.
Figure A5.
Figure A5.

St. Lucia: Public DSA-Stress Tests

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Source: IMF staff.

C. External Debt Sustainability Analysis

7. Under the baseline scenario, external debt is projected to increase gradually reflecting the expected increase in public debt. External debt is projected to reach 89 percent of GDP by 2021, up from 83 percent in 2016. Furthermore, the external debt path remains vulnerable to potential adverse shocks. Were key variables to remain at the historical levels seen in the aftermath of the Global Financial Crisis, external debt would be on an upward trajectory reaching 146 percent of GDP by 2021. The adverse shock scenarios also suggest vulnerability— under the growth, interest rate, current account, and combined shock scenarios, external debt rises throughout the forecast period. The most severe effects are observed under the real exchange rate depreciation scenario, which would result in a step increase in external debt to around 124 percent of GDP in the year of the shock and reaching 132 percent by 2021. The vulnerability suggested by this scenario is mitigated by the regional central bank’s near-currency board-arrangement.

Table A1.

St. Lucia: External Debt Sustainability Framework, 2011-2021

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure A6.
Figure A6.

St. Lucia: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2010.

Annex IV. External Sector Assessment

St. Lucia’s external position is weaker than implied by fundamentals and desirable policies. The estimated current account gap is -1.4 percent of GDP and the EBA-lite methodology suggests an overvaluation of the real effective exchange rate of about 5 percent. However, St. Lucia needs to address its considerable structural weaknesses in order to boost competitiveness. Measures targeted at improving the business environment, removing labor market rigidities, and diversifying the export base would not only boost income, but also make the economy more resilient to natural disasters, which disproportionately weigh on the traditional sectors such as agriculture and tourism.

1. St. Lucia’s current account (CA) balance has improved in recent years, but a deterioration is expected in 2016. After a long stretch of double digit deficits, the external balance started improving in 2011 on account of rising tourism receipts and favorable movements in commodity prices. The 2015 CA estimate has been recently revised upward to - 2.6 percent of GDP owing to a better than expected outturn in tourist arrivals —particularly from the United States— and a smaller than anticipated deficit in trade in goods. For 2016, staff estimates a deficit of -6.7 percent on account of underperforming exports and a 5 percent drop in tourist expenditures. 1

A01ufig9

Current Account Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

2. Based on the EBA-lite methodology, the CA deficit in 2016 is wider than implied by medium-term fundamentals and desirable policies. The CA-regression approach of the EBA-lite methodology yields a CA norm of -5.4 percent of GDP, implying a CA gap in of about -1.4 percent of GDP in 2016 and an overvaluation of the effective exchange rate of about 5 percent. The results of the EBA-lite REER model point to an overvaluation of the same magnitude. However, high unemployment and low output growth point to a deeper competitiveness problem.

St. Lucia Exchange Rate Assessment EBA-lite Model Estimates (2016 in percent)

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Source: IMF staff estimates and calculations.

Positive number indicates overvaluation.

A01app4ufig1

REER Appreciation

(In percent, year-on-year contribution to growth)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: INS Database; and IMF Staff Estimates.
A01app4ufig2

Effective Exchange Rate Indexes

(2012=100)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: INS Database; and IMF Staff Estimates.

3. After a few years of steady appreciation, the REER has weakened since mid-2015. The real effective exchange rate had been steadily appreciating since 2011, mostly on account of the nominal appreciation of the U.S. dollar to which the E.C. dollar is pegged. Some depreciation was recorded beginning in the second half of 2015, driven mostly by the inflation differential. The effect of a depreciation, however, is likely to be limited owing to the very narrow export base and to the low price elasticity of tourism, which reflects St. Lucia’s focus on high end tourism.

4. Tourism performed strongly in recent years, but a slowdown was experienced in 2016. After the loss of preferential access of the banana industry to the European markets, the agricultural sector gradually declined over the last two decades and tourism became St. Lucia’s most important export sector. With a share of about 32 percent of total stay-over arrivals, St. Lucia is the largest tourist destination in the ECCU, but its market share has recently declined. In 2016 the tourism sector underperformed, recording no growth in stay-over arrivals and a large drop in cruise-ship visitors as well as tourist expenditures. To boost the attractiveness of the island, the government is negotiating with foreign investors to add new resorts in the medium term. On the other hand, the planned increase in the airport tax might adversely affect tourist arrivals.

A01app4ufig3

Shares of Total Caribbean Stay-Over Arrivals

(Percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: ECCB; and IMF Staff Estimates.
A01app4ufig4

Shares of Total ECCU Stay-over Arrivals

(Percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: ECCB; and IMF Staff Estimates.

5. Due to structural weaknesses, the CA deficit is expected to widen gradually over time. Over the medium term, the current account deficit is projected to return to double digits, reflecting gradually rising commodity and fuel prices, higher FDI-related import growth, and structural weaknesses constraining productivity, export growth, and the diversification potential. Being a small island economy, St. Lucia suffers economies of scale disadvantages, which make any attempts to diversify the production base challenging. However, a more diversified export base could help boost income, and protect the country from fluctuations caused by external shocks and natural disasters, and by the seasonal nature of tourism. To increase competitiveness, St. Lucia needs to address a number of structural weaknesses. According to the latest edition of the Doing Business Indicators of the World Bank, the country’s overall ranking has dropped from 78 to 86 in 2017. The report highlighted high export and import costs as one of St. Lucia’s notable weaknesses. Energy and transport costs are also high while access to credit is limited. High unit labor costs and a marked disconnect between wages and productivity —partly reflecting the large share of public sector employment and strong unions— are further weighing on St. Lucia’s external competitiveness.

A01app4ufig5

St. Lucia: Key Doing Business Rankings (2016 vs. 2017)

(Position in sample of 190 economies, higher = worse ranking)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: World Bank, Doing Business Indicators.
A01app4ufig6

St. Lucia: Productivity, Wages, and Unit Labor Costs

(Index, 2001 = 100)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: Haver Analytics; National Insurance Scheme; National Authorities; and IMF Staff Estimates.

6. Imputed net international reserves held at the ECCB remain above the reserve adequacy thresholds. As a member of the ECCU, reserve adequacy is assessed based on the net imputed reserves held at the ECCB. The reserve coverage of about 18 percent of GDP in 2016 corresponds to about 5 months of imports and 23 percent of broad money, exceeding the benchmarks of 3 months and 20 percent, respectively.

A01app4ufig7

Foreign Currency Reserves and Adequacy Thresholds

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: Country Authorities; and IMF Staff Estimates.

Annex V. Government Wage Bill in the Caribbean1

1. In ECCU countries, the government wage bill is the largest expenditure outlay and governments are the largest employers. In St. Lucia, the wage bill rose to 34 percent of total expenditure in 2015, considerably above the 27 percent average for Emerging Market and Middle-Income Economies. As in other ECCU countries, the public sector is the single largest employer in St. Lucia, accounting for 13 percent of total employment in the island, and for approximately a fifth when including apprenticeship schemes.

A01app5ufig1

Public Employment as a Percentage of Total Employment in 2014 1/

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

1/ AS stands for Apprenticeship Schemes.

2. Several reasons explain the high wage bill and public sector employment in the ECCU and St. Lucia. Indeed, there are several historical, structural, and policy related factors behind this:

  • Historically, ECCU governments expanded in the post-independence period to support economic and social development. New ministries and departments were created for this purpose.

  • Providing public services has fixed costs, so the cost per capita in small countries is higher and the civil service larger in relation to the size of the economy.

  • Wage setting is governed by collective bargaining with very strong and active trade unions across the ECCU. This situation is more prevalent within the public sector where trade union density is highest.

  • Schemes such as incremental pay progression and promotions and retroactive wage negotiations have delinked wages from productivity. This was most evident in the last downturn following the Global Financial Crisis, when the wage bill increased by 3 percent per annum over the period 2009-2012 while GDP was falling.

  • Governments find it politically difficult to reduce public employment during economic downturns when unemployment is high and social safety nets are insufficient.

3. These reasons also explain the large wage increases experienced by St. Lucia in recent years. With the exception of the wage freeze during 2013-2016, wage increases averaging 3 percent annually have been granted since 2008. Furthermore, the retroactive approach to wage negotiations could lead to substantial increases in the wage bill in subsequent years, which are inconsistent with forward-looking fiscal targets.

4. Wages have been generally high in the ECCU and St. Lucia relative to peer countries. World Bank (2005) provides a comparison of wages paid to different job positions (including in occupations that are relevant to the public sector such as teachers, nurses, and clerks) 2. The report shows that wages are higher in the ECCU than in other Caribbean, upper middle income countries and microstates. The combination of high wages with persistently high unemployment suggests that labor markets do not function efficiently.

5. The composition of the civil service may not be optimal in ECCU countries. Severe shortages of skilled labor across the region, aggravated by a large brain drain, are reflected in a small share of middle and senior technical staff in the core civil service. There is also a similar shortage of doctors in the public health system. On the other hand, the public service seems to have more than enough teachers and nurses with very high teacher-to-student ratios relative to comparator countries, although educational outcomes are not satisfactory. World Bank (2005) observes that St. Lucia, while having a more adequate supply of secondary graduates than Guyana or the Dominican Republic, suffers from the most severe shortages with respect to post-secondary and university educated workers. In the World Bank assessment, there is scope in the ECCU region to reallocate spending from teacher salaries to other areas, without radically increasing per capita spending or reducing outcomes.

6. Managing the wage bill should be considered within the broad context of civil service reforms aimed at improving service delivery and reducing costs. This begins with rethinking the role of public service and defining a service-oriented bureaucracy that adequately satisfies the needs of the population. In the short term, this requires narrowing the array of services provided by the government and letting the private sector play a role where appropriate. The following broad components of an institutional reform framework are suggested:

  • Legislative reforms and amendments to rationalize existing policies and rules and implement new legislation for the introduction of the reform program. There is a need for regulations that guide and facilitate the “rightsizing” effort and install flexible personnel management practices. Ceilings on wages and/or employment can help promote consistency with fiscal objectives.

  • Functional review and human resource audits. The former focuses on identifying core governmental functions, eliminating duplication, and consolidating and/or merging similar services from different ministries, departments and agencies (MDAs) of government. The latter is useful to establish the adequate size and skill set of the civil service.

  • Information management systems for human resources and central personnel. These would facilitate sustained and efficient staff performance and the achievement of the civil service’s goals.

  • Budgetary institutions and fiscal planning frameworks should be strengthened to support budget planning and preparation as well as the management and the control of the wage bill. Negotiations for wage increases should be guided by macro indicators including cost of living adjustments, affordability or fiscal sustainability, productivity growth/performance outcomes, but also comparators with the private sector and statutory bodies.

  • A shift to medium term performance-based budgeting and alignment with sectoral strategies would facilitate better assessments of budget outputs and results with performance outcomes and with productivity and efficiency.

  • Compensation and performance systems. These should build on the outcome of the functional review to establish job classifications, fair remuneration and performance mechanisms that will (i) facilitate the recruitment and retention of high−quality employees and (ii) reward performance with compensation and career development opportunities.

Annex VI. Unemployment in St. Lucia and the ECCU1

1. Unemployment rates are high in most ECCU countries. With the sole exception of St. Kitts and Nevis, ECCU members are characterized by double digit unemployment rates driven by both cyclical and structural factors.

2. Structural factors play a key role in explaining high unemployment in the ECCU. The region has gone through a considerable structural transformation since the 1990s when the European Union severely weakened its trade preferences for imports of bananas from the Caribbean. The previously thriving industry was significantly downsized, leading to large reductions in formal employment. In St. Lucia, the 33-percent drop in agricultural employment between 2001 and 2013 translated into a 6-percent drop in total employment. Labor demand is further affected by the recurrence of natural disasters, which affect employment in agriculture and to a lesser extent in construction, tourism, and transportation. In addition, employment in the ECCU is characterized by seasonal fluctuations, mostly connected with tourism. In St. Lucia, unemployment rises by about two percentage points in the low tourist season.

A01app6ufig1

Unemployment Rate

(In percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: World Bank, WDI, and “Youth Unemployment in the Caribbean”; National Authorities; and IMF Staff Calculations.

3. Unemployment rates increased considerably in the wake of the Global Financial Crisis. After a period of considerable expansion during the 2000s, annual output either stagnated or contracted in all ECCU countries after 2008. In St. Lucia, the weaker tourism outlook at the onset of the crisis translated into an immediate contraction in employment in hotels, restaurants, and construction while agricultural employment stagnated. Between 2008 and 2015, St. Lucia’s unemployment rate rose from 15.8 to 24.1 percent, one of the highest in the region.

4. Female and youth unemployment are particularly high in St. Lucia. Youth unemployment is about twice as high as overall unemployment in ECCU countries. In St. Lucia, as much as half the population between 15 and 24 years of age is unemployed. The gender disparity is also alarming, as the gender gap was about 7 percent in 2014, similar to only some other Caribbean countries (Jamaica, Dominican Republic) and countries in the Middle East and North Africa.

5. A skills and vocational mismatch contributes to unemployment in St. Lucia and other ECCU countries. The 2012 national labor market needs survey confirmed the gap between firms’ demand for skilled labor and the quantity supplied by the market in St. Lucia. However, the fact that unemployment is particularly high among young people, which have generally higher education levels than the rest of the population, could indicate that additional factors are at work. The low diversification of the economy limits the range of employment opportunities available and can be part of the reason for the mismatch.

Figure 4a:
Figure 4a:

Wages and Productivity Growth 1/

(In percent)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: National Insurance Services (NIS).1/ Change between 2007-08 and 2012-13

6. High unemployment reflects labor market rigidities, possibly strong unions. The strong disconnect between real wages and productivity helps explain the persistence of high unemployment. In St. Lucia, real wages increased both in the public and the private sector despite a substantial decline in productivity since the beginning of the global financial crisis. This phenomenon could be explained by strong labor union activity and its impact on wage setting. Even though the ECCU is characterized by a fairly low density of labor unions, the coverage of workers in collective bargaining agreements is high, unions are very well organized and politically influential, and they cover large key sectors. In St. Lucia, public sector wages have grown faster than in the private sector and have generally led through demonstration effects, which are evident in the practice of private sector unions to negotiate wages using public sector wages as a benchmark.

A01app6ufig2

Female to Male Unemployment Ratio 1/

(2014)

Citation: IMF Staff Country Reports 2017, 076; 10.5089/9781475590906.002.A001

Sources: World Bank, WDI and National Authorities.1/ Female divided by Male Unemployment Rate.

7. Determined policy actions are needed to reduce high unemployment in ECCU countries. In particular, efforts should be made to better align wage and productivity growth. Boosting productivity in small island economies requires measures targeted at increasing economies of scale through international and intraregional integration, improving the investment climate, lowering the cost of energy through investment in renewable sources, and setting up labor training programs and an education system in tune with labor market demand. Controlling public sector wage growth and increasing wage-setting flexibility while protecting basic workers’ rights should also be considered. Particular attention should be given to understanding the reason for the large gap between male and female unemployment.
1

Besides the “Five to Stay Alive” manifesto, the electoral platform includes plans to increase the personal income tax threshold to EC$25,000 and reduce in the corporate tax rate from 30 to 25 percent within three years.

2

Owing to small fiscal multipliers, the positive impact of the VAT reduction on growth will likely be negligible. Conversely, under plausible assumptions on the price elasticity of long-haul leisure travelers, staff projects the negative effect of the airport tax on tourist arrivals (-14 percent) and growth (-1.4 percent) to be significant.

3

In line with the empirical evidence, the baseline scenario assumes only a partial pass-through from global rates to regional/domestic rates (Myrvoda, A. and J. Reynaud, “Monetary Policy Transmission in Eastern Caribbean Currency Union”, IMF WP, forthcoming).

4

The Financial Services Regulatory Authority (FSRA) regulates and supervises 16 credit unions, 26 insurance companies and a sales force of 18 agents, 11 brokers and 210 salesmen, 9 active international banks (branches), 14 mutual funds, as well as 22 registered agents and trustees providing financial services representation on behalf of international business companies and trusts.

5

The conclusions of the preliminary report of the external consultant are broadly in line with previous FAD recommendations.

1

The analysis of public debt sustainability is based on the framework developed for market access countries. See Staff Guidance Note for Public Debt Sustainability Analysis in Market Access Countries, IMF, May 2013.

1

Staff projections are based on data compiled using the BPM5 methodology. The authorities are currently working on transitioning to the BPM6 methodology while simultaneously improving the quality of balance of payments statistics through broader coverage and methodological enhancements. Revised balance of payments data for 2014 and 2015 are expected to be released in 2017. Provisional data for 2014 point to a substantial improvement of the current account balance resulting from enhanced estimates of travel credits.

1

Prepared by Gonzalo Salinas, based on James, Ronald and Wayne Mitchell, “Government Employment and Wage Bill in the ECCU Member Countries, IMF Working Paper, forthcoming.

2

World Bank, 2005, “Organization of Eastern Caribbean States - Towards a New Agenda for Growth,” Report No. 31863-LAC, Washington: World Bank.

1

Prepared by Veronika Sola, based on Lafeuillee, Li, James, Salinas, Savchenko: “Explaining high unemployment in ECCU countries”. IMF Working Paper, forthcoming.

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Cover IMF Staff Country Reports
St. Lucia: 2017 Article IV Consultation-Press Release and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2017: Issue 076
Publisher:
International Monetary Fund
ISBN:
9781475590906
ISSN:
1934-7685
Pages:
75
DOI:
https://doi.org/10.5089/9781475590906.002
Figure 1.

Mixed Macroeconomic Outcomes Despite Favorable Global Conditions

Employment
Figure 2.

Strengthening the Financial Sector

2015: Goverment Tax Revenue

(In percent of GDP)

2015: Components of Total Tax Revenue

(In percent)
Figure 3.

Main Social Spending Items Relative to Comparator Groups

2015: Goverment Spending

(In percent)

Public Capital Stock

(Latest value available)
Figure 4.

Baseline, Passive, and Adjustment Scenarios
Figure 5.

Structural Reform Priorities to Drive Growth
Figure 6.

Unemployment in St. Lucia

Public Debt

(percent of GDP, fiscal years)

St. Lucia: Loans-to-Deposits Ratio

(Percent)

St. Lucia: Liquid Assets

(Percent)
Figure A1.

St. Lucia: Public DSA Risk Assessment
Figure A2.

St. Lucia: Public DSA – Realism of Baseline Assumptions
Figure A3.

St. Lucia: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP, fiscal-year basis, unless otherwise indicated)
Figure A4.

St. Lucia: Public DSA-Composition of Public Debt and Alternative Scenarios
Figure A5.

St. Lucia: Public DSA-Stress Tests
Figure A6.

St. Lucia: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Current Account Balance

(In percent of GDP)

REER Appreciation

(In percent, year-on-year contribution to growth)

Effective Exchange Rate Indexes

(2012=100)

Shares of Total Caribbean Stay-Over Arrivals

(Percent)

Shares of Total ECCU Stay-over Arrivals

(Percent)

St. Lucia: Key Doing Business Rankings (2016 vs. 2017)

(Position in sample of 190 economies, higher = worse ranking)

St. Lucia: Productivity, Wages, and Unit Labor Costs

(Index, 2001 = 100)

Foreign Currency Reserves and Adequacy Thresholds

(Percent of GDP)

Public Employment as a Percentage of Total Employment in 2014 1/

Unemployment Rate

(In percent)
Figure 4a:

Wages and Productivity Growth 1/

(In percent)

Female to Male Unemployment Ratio 1/

(2014)